As the sell-off of Russian debt continues, U.S. banks are buying cheap Russian government or corporate bonds and credit-default swaps, which act as insurance on a borrower’s potential default. Called a negative-basis trade, such a purchase typically makes little sense, but as institutional investors race to cleanse their portfolios of anything tainted by Russia, the volume of trading has reached a two-year high, according to Bloomberg News.
Russian sovereign debt traded at a volume of $7 billion between February 24 and April 7, the first phase of the war, compared to $5 billion during the same period in 2021, according to MarketAxess data.
"There's a lot of speculators that are buying up these bonds that have been severely downgraded and are on the verge of becoming junk," Philip M. Nichols, Professor at the University of Pennsylvania's Wharton School, told CNN. "The spread on Russian sovereign debt is astonishing right now. They're making an unusual amount of money with respect to the volume."
The cost of insuring the debt rose 1,500 basis points in one day in early April, while at the same time, bond rates plummeted. Bonds maturing in 2028 were trading at just $0.34 on the dollar, which means insuring $10 million of Russian securities would cost just $4 million, The Economist reported.
Hedge funds that have a high risk tolerance and lower moral threshold, including Aurelius Capital Management, GoldenTree Asset Management, and Silver Point Capital, have been purchasing Russian corporate bonds, the Financial Times reported. Financial institutions such as JPMorgan Chase and Goldman Sachs are facilitating the trades by connecting clients with the hedge funds.
"This is Wall Street," Kathy Jones, Chief Fixed Income Strategist at the Schwab Center for Financial Research, told CNN. "It doesn't surprise me that they saw some sort of a loophole they could exploit to make money."
